Harness the Power of Compounding

23.8.08:

Time as an investment ally:

Compounding is a wonder tool that lets you make the most of small investments made over long periods of time to accumulate phenomenal wealth. It works best if you start investing early, and leave the money alone. Compounding is, in fact, the single most important reason for you to start investing right now. Every day you are invested is a day that your money is working for you, helping to ensure a financially secure and stable future.
Invest regularly:

Probably the most important thing you need to know about building wealth is the power of making regular periodic investments and reinvesting rather than spending the profits.

The results you’d get following this discipline are surprising. Say you start with nothing, but decide to put Rs 1000/- of your income into an investment account every year or still better, every month, and you commit to letting your money ride. That means you can’t take withdraw any funds until you’ve reached your long-term goal.

Now let us take another variable in the rule 72 formula,

The principal sum:

We have seen in our previous article how a one time investment of Rs. 1000/- invested @26% p.a. compound rate of interest at a time when you are 20 years old can make you crore pati ( Rs.1.0347 Cr.) by the time you are 60.

Now what happens when you invest Rs. 1000/- every year @26% every year ever since you are 20 years of age till you are 60?

Can you imagine receiving little more than Rs one crore every year after attaining the age of 60 for the next 60 years non stop! Just think it over.

Now let us expand this concept to saving of Rs.1000/- per month @ 26% p.a. beginning at the age of 20 till you are 60.

You will receive over Rs one crore every month beginning the 61’st year of you life for the next 60 years non stop without having to go to office to work for some body. You can have all the time and fun in the world and can do things you always wanted to do.

Discipline Required:

The hardest part of implementing this strategy is making the regular monthly investments. It’s easy to procrastinate adding to your account if the market is down or if you could use the cash for something else.

The best way to make sure that the regular investments happen is to set up an account with a broker or mutual fund that automatically deducts a fixed amount from your bank account every month.

While you could do it with stocks, the easiest way to implement the strategy is with a portfolio of well-chosen mutual funds that are likely to produce returns at least even with the market, and if you’re lucky, beat the market. A little goes a long way in that department.

Moral of the story is to Invest regularly:

Develop the habit of adding to your mutual fund account on a regular basis, perhaps monthly. You may be able to have this done automatically by setting up a systematic investment plan with your mutual fund. By investing regularly you take advantage of a strategy called rupee-cost averaging. Regular investing, however, does not ensure a profit or protect against loss in declining markets but markets are fairly predictable in the long run.

The overall market, at least as measured by the BSE index, returned over 26%, on average, annually over the past 50 years.

Warren Buffett, the richest man in the world today, has created all the wealth from investments in stocks, has generated a return of apprx. 26% compounded on his initial investment of $ 7.6 per share in Berkshire Hathaway and is worth ove $ 1,50,000/- per share today.